Over the years, we have spent thousands of hours talking with our traders and answering their emails. We have a huge collection of really great information that only benefited the specific traders who we were interacting with. So, we decided to start sharing all of these gems of knowledge with everyone.

Tuesday, November 24, 2015

Today looked to be the start of a pullback; however, the markets regained their losses, closing slightly higher on the session. We anticipate that the markets will continue moving sideways going into the holiday, with just 1.5 trading days left this week. All three majors are still below previous support levels, but back inside their ranges.

We will see a decent amount of economic news tomorrow, including jobless claims and durable goods orders. Reports like these can always have an impact on the markets, based on the severity of the results. However, given the holiday just around the corner, any reaction should be temporary at best. Expect this range to tighten a little over the next couple of days. We don't anticipate too many opportunities until early next week.

Monday, November 23, 2015

From Our November 2015 E-mail Archives: Our Head Trader, Robb, sent an e-mail to one of Maverick's traders regarding his short/naked put position and suggested a better alternative to trading naked.*

-----Message-----

In this case, there was only an e-mail from Robb to the trader and no original e-mail message from the trader. At Maverick Trading, we constantly review our traders' accounts to ensure proper risk management. Robb was doing this when he came across a trader with short put options in his account. Robb sent the e-mail below, which we believe is important for all of our traders to see.

Hi Tom,

As I was going through trader accounts, I wanted to drop a quick note to you. I noticed that you were in several Short/Naked Put positions. While the Short Put position carries some serious risk, we definitely like it better than a Short Call position.

Whenever I see someone selling/shorting options, I want to make sure that they understand that the math shows a Bull Put Spread (or Bear Call Spread) is superior to a Short Put as far as % return and absolute risk.

To illustrate this, let’s use your five (5) contracts short position in KMI December 25 puts:

Short Put Position

Position: Short 5 x KMI - December 18th – 25 puts

Entry Price: 0.90

Profit Potential: $450 (less commissions)

Absolute Risk: $12,050 (While this is the absolute risk if the stock goes to $0, we understand that is very unlikely; however, this is the absolute risk and you will occasionally have trades that lose 50%+)

2 SD Risk: $1,905 (A 2 standard deviation move down was calculated at 20.29 at the time of your trade entry)

Return on 2 SD Risk: 23.6%

Margin Required: $1,685

Return on Investment (margin): 26.7%

Now, let’s compare the above to a 5 contract position of a KMI December 18th 22/25 Bull Put Spread.

Bull Put Spread

Position: 5 x KMI - December 18th - 22/25 Put Spreads

Short 5 x KMI - December 18th - 25 puts: 0.90

Long 5 x KMI - December 18th - 22 puts: 0.20

Total Credit: 0.70

Profit Potential: $350 (less commissions)

Absolute Risk: $1,150 (While this is the absolute risk if the stock goes to $0, we understand that is very unlikely; however, this is the absolute risk and you will occasionally have trades that lose 50%+)

2 SD Risk: $1,150 (A 2 standard deviation move down was calculated at 20.29 at the time of your trade entry)

Return on 2 SD Risk: 30.4%

Margin Required: $1,150

Return on Investment (margin): 30.4%

Comparing the two side by side, you can see the Bull Put Spread delivers both a superior Return on Risk and Return on Investment. When you look at Absolute Risk and even a 2 standard deviation move, the Bull Put Spread is superior.

At Maverick Trading, we always discuss capital allocation. In the two scenarios above, the Bull Put Spread will tie up less of your trading capital. This would become even more evident if this was a higher-priced stock. If you did the same analysis above on a $100 stock, then the margin on a Short Put would be just below $10,000, while the Bull Put Spread would still be $1,150.
When compared side by side, the Bull Put Spread has much better “math” (and, thus, makes more sense) than the Short Put strategy.

With that said, there is a price point where the Short Put and Bull Put Spread are fairly comparable. We have found this to be around a $10-15 price on the underlying stock. Even then, though, the Short Put will always carry more Absolute Risk, which still makes the Bear Put Spread superior.

Hopefully, I have laid out everything in logical detail. While I don’t hate the Short Put strategy, it is so much better to just buy a far out-of-the-money (OTM) spread. I tell traders that if you want to sell a $100 put, then also buy a far OTM $90 put for 0.10. It changes the entire dynamic of the trade and makes it safer because of the Absolute Risk of the Short Put strategy. I suggest that you take a look at your trading plan and see if this makes sense for you.

Thursday, November 19, 2015

The markets hesitated once again after another strong move higher yesterday. Overall, we have seen a pretty decent move to the upside this week, as each upward move is followed by a stagnant sideways day. There are some signs of reluctance from the bulls after each move higher. So far, we haven't seen an answer from the bears. The markets appear determined to get back to last week's levels.

We haven't seen much from the news headlines. With no change in the Fed policy, we should expect more of the same. Take into consideration, and respect, current support and resistance levels. We should continue to see opportunity in the out-performing stocks and sectors as we enter December's expiration next week.

Continue to implement bullish to sideways strategies into your portfolio and stay adjustable on a weekly basis if possible. November expiration ends tomorrow after the close. Make sure to address your positions and make the necessary adjustments for Monday.

Tuesday, November 17, 2015

The markets hesitated today after a strong bounce on Monday. In light of the devastating terrorist attack overseas, the markets showed resilience and rallied on Monday’s session. The markets had already been moving lower previous to the terrible event and could have been due for a bounce, although today’s candlestick looks to have put a temporary halt on this recent bullish push.

The U.S. markets have been experiencing their first "real" pullback over the last couple of weeks since climbing back into previous highs set earlier this year. This pullback has been a little more aggressive than we anticipated. However, in comparison to the bullish surge off the bottom, it is pretty much in line. Technically, we are in the middle of a possible higher pivot low being formed, with tomorrow's candle being the last needed piece of confirmation.

So far, the markets are acting as discussed in Sunday’s Trading Room, with high volatility Monday and indecision today. Where the markets go from here will be a strong indication to overall sentiment.

Monday, November 16, 2015

From Our October 2015 E-mail Archives: Today, our Our Head Trader, Robb, answers a question from one of Maverick's traders about when an option becomes "too expensive."*

-----Original Message-----

From: Alonzo D.Subject: Trader Question!

Hi Robb,

You often speak of paying too much for an option. What is the max that you are willing to pay in time value for an option that you go long on? Long Call/Put vs. one leg of a spread.

Thanks,
Alonzo

-----Reply Message-----

Hi Alonzo,

Thanks for the email – it’s a great question. The concept of “too much” is all relative to the trader, so I can only give you my personal feedback.

As you know, options prices are due to time and volatility. Since time is fixed, volatility is really the thing that will increase the price of the option. So, Implied Volatility (IV) will be the thing that makes it “too expensive.” However, IV is simply a result of supply and demand for the option – using the Historical Volatility (HV) of the underlying.

Efficient market theory believes that the market price is the “correct price.”If you believe the efficient market theory (which I do), then every option is priced correctly. Thus, for me as a trader, “too expensive” simply means my Risk/Reward is no longer worth it.

Let me give you an example.

CMG has earnings tonight [October 20, 2015] after the close. Let’s say I wanted to buy at the money long calls going into the report, as follows:

CMG Price: $712.52

CMG November (next month) 710 Call Price: $35.00

When I am building the trade, I have to figure out T.E.S.T. (Timeframe, Entry, Stop and Target) and run the numbers. I have to plan out my max risk (projected or absolute) and my reward potential. Let’s use the following numbers for CMG:

Timeframe: 2-3 days

Entry: 712.52

Stop (abandon or adjust price): 642.52 – I simply used ATM long calls and puts added together to get the projected move of CMG after earnings.

Target: 857.50 – I used a 61.8% Fibonacci extension to get this number. Remember, though, that targets are nothing more than slightly educated guesses as to where this is going.

Now, let’s calculate the Risk/Reward of the long call play with exiting at both our stop and target prices. I used a risk graphing calculator to get these projected values in 2 days. I also used a 50% drop in IV since that is fairly typical with an active stock after earnings.

Risk: $3,427 (you are basically at max absolute risk since the original call price was $35)

We are finally at the bottom line where we decide whether the option is “too expensive.” If it can’t justify the risk with at least a 2X reward, then this is when I say the option is too expensive.

As you can see, things like stop and target prices are subjective to each trader and can lead to different numbers. As we always say, “Consistency is the most important thing in trading. Even though two different traders use different numbers, they should have close to the same results after thousands of trades.

So, after my long, detailed answer, the short answer is when there is not enough upside to justify the price of the option.

Thursday, November 12, 2015

The markets made a decent move lower today, led by weakness in energy and materials. The S&P and INDU both fell below their 200-day MA’s; however, both are still above major support levels for the time being. Although recent economic reports have been pretty much flat, rumors of a possible rate hike in December continue to loom. This has created some volatility in the markets and could continue to do so moving forward.

The markets have been in a pull back all week and today’s move was the largest so far. Technically, we are still in a corrective pullback, as all three majors are still above major support levels. We will see more economic data tomorrow – specifically, the PPI and retail sales, either of which could have an impact on tomorrow’s action.

Market sentiment seems to be focused on the threat of an interest rate hike or the worry of weakness moving forward. Either way, this move lower doesn’t appear to be finished just yet.

Tuesday, November 10, 2015

The markets have been in a steady pullback over the last few days, which has brought us back to support levels. Today’s candle could be the beginning of a higher pivot low formation in the markets. If these support levels hold, then we should see some decent bullish opportunities moving forward.

Make sure that the lower pivot has formed before moving into aggressive bullish trades. Until the next bullish move is confirmed, continue to take advantage of horizontals and diagonals. Staying adjustable makes it easier to increase our bullish exposure if the markets decide to continue higher from here.

Stay patient in your trades – corrective market action can create unfavorable movement in both bullish and bearish positions at the same time. Keep in mind that we are trading the overall trend and not just a move.

Thursday, November 5, 2015

The markets hesitated for a second day in a row, with little bearish presence. With the markets at these levels, we will continue to keep a bullish – but cautious – stance. We aren’t seeing enough bearish movement to justify aggressive long positions here. It would be nice to see a bull pullback out of these markets before entering more bullish trades, but we might not see one of significance for a little while.

Not much has changed over the last week and we should continue to respect – and trade – the markets in front of us. We have seen slow moving, stubborn bull moves in the past. If played cautiously, they can generate decent returns. Continue to follow market sentiment. Things could be looking a little over extended out there, but stay true to the trend. Don’t try and guess a top here...you will be wrong.

Tuesday, November 3, 2015

The markets continued to push higher as they look to be closing in on the upper range set earlier this summer. This bullish move has been very direct, with very little bearish resistance. Earnings results have definitely played their part – although they haven’t all been great, there seems to be more bullish reaction than bearish.

The markets are showing signs of over-extension as this bullish move continues. We don’t want to try and guess a top or quit taking advantage of bullish trades; however, leaning towards a more sideways outlook could help reduce exposure with a market correction. Overall we need to stay bullish along with the current market sentiment.

Continue to follow earnings results as we continue through the season. We have seen some great opportunities out there, especially after results. So, stay diligent and follow your rules.